Update on Government's Bank Investment

The issuance terms are standardized across the industry. A bank must apply for a minimum of 1% and a maximum of 3% of risk-weighted assets, or $25 billion, whichever is smaller. This ensures that the infusion will be meaningful. The perpetual preferred stock will yield just 5% annually for the first five years before rising to 9%. The preferreds are callable after three years, giving the banks a chance to avoid the higher dividend payments, or they can be paid off early if a bank can replace the funds through a private market issuance of Tier 1 qualifying capital. These preferred shares are on an equal level with existing preferred shares, which can still pay dividends. Banks that use this facility cannot buy back common shares and need Treasury permission to increase the dividend on common stock. The government will also take warrants equal to 15% of the preferred stock investment. The strike price of the warrants will be based on the 20-day moving average of the stock before issuance.

According to reports, the government will invest $25 billion in Citigroup C, J.P. Morgan JPM, the about-to-be-combined Bank of America BAC and Merrill Lynch MER, and Wells Fargo WFC. Goldman Sachs GS and Morgan Stanley MS will receive $10 billion, while Bank of New York Mellon BK gets $3 billion and State Street STT takes on $2 billion--taking up about half of the $250 billion government investment. Overall, we think the government made the terms attractive enough for banks that didn't need the capital to take it. Our numbers suggest any changes in our fair value estimates will be minor.

In addition, the FDIC will guarantee most senior unsecured debt, including interbank lending, issued on or before June 30, 2009, for a maximum of three years for a 75-basis-point fee--a major initiative to bring down LIBOR and get the credit markets moving again. The FDIC will also remove the $250,000 limit on insurance for non-interest-bearing deposits, but will charge the banks a 10-basis-point fee for this new guarantee. This initiative is aimed at business accounts, which often use non-interest-bearing accounts in their daily cash management. Finally, the government is preventing the banks that use this facility from using certain tax credits on high management salaries. It also requires that new employment contracts do not include golden parachutes and imposes a clawback provision on upper management bonuses where financial statements were found to be materially misleading.